Federal Regulation and Chemical Innovation - ACS Publications

1 Chemicals as a Regulated Industry: Implications for Research and Product Development GEORGE C. EADS

Downloaded by UNIV OF NEWCASTLE on February 26, 2017 | http://pubs.acs.org Publication Date: September 5, 1979 | doi: 10.1021/bk-1979-0109.ch001

Regulatory Policies and Institutions Program, The Rand Corporation, Santa Monica, CA 90406

Governmentally imposed restrictions on private enterprise are not a new phenomenon. For about 100 years, certain indust r i e s , such as the railroads and the electric utilities, have operated under detailed regulation, and even the so-called "unregulated" industries have been subject to antitrust, securities, tax, and labor laws. It is now widely recognized, however, that government regulation has entered a new era. This era began in the mid-1960s with the passage of a series of laws aimed at, among other things, protecting the environment, insuring worker health and safety, and assuring the safety and performance of consumer products. This "new regulation" applies to a l l private enterprise, and is administered by a multiplicity of agencies, each interested only in specialized segments of a firm's operations. In further contrast with traditional regulation agencies, the regulators in these new agencies have no specific mandate to promote the industries they regulate or even to assure the continued existence of these industries. A number of observers, both within and outside government, have expressed concern that this new use of regulation is fundamentally altering the behavior and performance of U.S. private enterprise, with potential repercussions far beyond the intended scope of regulatory activity. One reason for concern is the fact that the increase in regulatory activity requires that a larger share of U.S. economic and social resources be devoted to supporting the regulatory bureaucracy, to assuring effective and appropriate representation of firms' interests before regulatory bodies, to gathering and processing numerous data requests made by government agencies and their contractors and, f i n a l l y but certainly not least important, to complying with regulations once they are promulgated. Estimates of these costs vary widely, but some notion of their potential consequence is given by a recently published study by Denison (1) in which he estimates that compliance with environmental constraints introduced since 1967 diverted nearly one percent of 1975 nonresidential business resources away from final output, with another 0.42 percent diverted as a result of compliance with regulations to improve

This chapter is in the public domain. Published 1979 American Chemical Society

Hill; Federal Regulation and Chemical Innovation ACS Symposium Series; American Chemical Society: Washington, DC, 1979.


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FEDERAL REGULATION AND CHEMICAL INNOVATION

worker h e a l t h and s a f e t y . This may seem l i k e a small f i g u r e , but i t i s not. Denison estimates that by 1975, t h i s r e d u c t i o n was equivalent to knocking 1/2 of one percentage p o i n t o f f the economy's annual growth r a t e . T h i s , i n t u r n , represents f u l l y a 25 percent reduction i n the economy's long-term rate of improvement i n output per u n i t of input. Moreover, Denison reports t h a t the share of resources being d i v e r t e d has been s t e a d i l y r i s i n g . But the d i v e r s i o n of economic and s o c i a l resources away from f i n a l production may not be the only, or even the most important, cost of the "new r e g u l a t i o n . " V i r t u a l l y every aspect of the firm's s t r a t e g i c environment i s l i k e l y to be a f f e c t e d . Of spec i a l concern i s that the pace and d i r e c t i o n of t e c h n o l o g i c a l advance i s l i k e l y to be a l t e r e d i n ways that are not p r e s e n t l y predictable. H i s t o r i c a l l y , t e c h n o l o g i c a l innovation has been a prime force i n economic development. New processes and products have been c r e d i t e d with such d i v e r s e b e n e f i t s as increased employment, increased labor p r o d u c t i v i t y , new o p p o r t u n i t i e s f o r preventing and c u r i n g disease, greater consumer comfort, and improvements i n the balance of trade. Of course, i t i s a l s o argued that t e c h n o l o g i c a l development i s at l e a s t p a r t l y responsible f o r p r e c i s e l y the environmental, h e a l t h , and s a f e t y hazards to which the bulk of the "new regulat i o n " i s addressed. Therefore, some of the changes that regulat i o n may induce may be a l l to the good. But we need not deny the existence of technology created hazards i n order to be concerned about the p o s s i b l e negative e f f e c t s of t h i s r e g u l a t i o n on the rate of t e c h n o l o g i c a l advance. The issue i s not whether some r e g u l a t i o n i s j u s t i f i e d , but what t r a d e - o f f s our s o c i e t y i s w i l l ing to make between the s o c i a l and economic b e n e f i t s from f u r t h e r high rates of t e c h n o l o g i c a l advance and the losses assoc i a t e d with a c t u a l and p o t e n t i a l new product and process hazards. We are i n the very e a r l y stages of research aimed at exploring j u s t such questions as these. This paper i s intended to describe some of our p r e l i m i n a r y hypotheses and to expose our general approach to comment and c r i t i c i s m . The t a r g e t i n d u s t r y f o r our research i s chemicals. This choice has merit f o r s e v e r a l reasons. Chemicals has long been considered a prime example of an i n d u s t r y whose success has been based on a continued high rate of t e c h n o l o g i c a l innovation. T r a d i t i o n a l l y grouped among the "research i n t e n s i v e " i n d u s t r i e s , chemicals has been p a r t i c u l a r l y noteworthy f o r the extremely low p r o p o r t i o n of i t s R&D funds t h a t have been f e d e r a l l y s u p p l i e d . Thus i t i s l i t t l e wonder that researchers seeking to understand the process of i n d u s t r i a l innovation have been a t t r a c t e d to the chemicals i n d u s t r y and, i n p a r t i c u l a r , to i t s t e c h n o l o g i c a l l y most advanced f i r m s . But chemicals i s d i s t i n c t i v e i n another way. The i n d u s t r y has been a prime t a r g e t of the "new r e g u l a t i o n . " Indeed, with


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Chemicals as a Regulated Industry

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the p o s s i b l e exceptions of autos and s t e e l , no p r e v i o u s l y "unreg u l a t e d " i n d u s t r y has been subjected to a wider v a r i e t y of regulations. C e r t a i n l y among the h i g h technology i n d u s t r i e s , i t ranks f i r s t . The chemicals i n d u s t r y a l s o contains a s u f f i c i e n t l y l a r g e number of firms so t h a t a d i v e r s i t y of behavior l i k e l y can be observed. But more importantly, the chemicals i n d u s t r y , being h i g h l y dynamic, has always been i n the f o r e f r o n t of managerial i n n o v a t i o n s . As Chandler has noted, a chemicals f i r m , Du Pont, pioneered the m u l t i d i v i s i o n a l form of corporate o r g a n i z a t i o n . ( 2 ) Chemicals firms were among the f i r s t to e s t a b l i s h organized corporate research a c t i v i t i e s . And, as we have observed during our research, c e r t a i n of the firms i n the chemicals i n d u s t r y are taking steps to become a c t i v e p a r t i c i p a n t s i n the r e g u l a t o r y process. Therefore, i f U. S. i n d u s t r y i s indeed undergoing s i g n i f i cant changes as i t attempts to deal with the "new r e g u l a t i o n , " these changes should r e a d i l y be observable i n chemicals. M a i n t a i n i n g t h i s p a r t i c u l a r i n d u s t r y ' s past e x c e l l e n t performance i s of obvious importance to the economy. We have already r e f e r r e d to the i n d u s t r y ' s high rate of t e c h n o l o g i c a l advance. The new and improved products i t has developed have, i n t u r n , f u e l e d p r o d u c t i v i t y improvements throughout the economy. And, although more h i g h - l e v e l p o l i c y a t t e n t i o n i s u s u a l l y given to the problem and performance of such i n d u s t r i e s as s t e e l , chemi c a l s long ago surpassed most of these s e c t o r s i n c o n t r i b u t i o n s to the gross n a t i o n a l product. Furthermore, chemicals, stimul a t e d no doubt by i t s e n v i a b l e performance i n developing new produ c t s , has continued to make a strong p o s i t i v e c o n t r i b u t i o n to our balance of payments. One element of the chemicals industry--pharmaceuticals--has already been the s u b j e c t of intense study. Considerable a t t e n t i o n has been given to the r o l e that FDA r e g u l a t i o n may or may not have played i n an observed slowdown i n the rate of development and commericalization of new e t h i c a l drugs. T h i s i n t e r e s t i n pharmaceuticals has tended to draw research a t t e n t i o n away from the e f f e c t s t h a t have been f e l t by the other segments of the chemicals i n d u s t r y . T h i s i s unfortunate f o r , whatever i t s importance, the e f f e c t s of FDA r e g u l a t i o n on innovat i o n and product development i n pharmaceuticals i s l i k e l y to be q u i t e d i f f e r e n t from the impact generated by the type r e g u l a t i o n to which the nonpharmaceuticals p o r t i o n of the chemicals i n d u s t r y has become s u b j e c t . As we s h a l l argue i n more d e t a i l below, d e a l i n g with such r e g u l a t i o n s and with the e n t i t i e s that promulgate and promote them creates a fundamentally d i f f e r e n t p l a n n i n g problem f o r a f i r m than does coping with r e g u l a t i o n s administered by an agency which has a scope of i n t e r e s t and r e s p o n s i b i l i t y roughly corresponding to the boundaries of the i n d u s t r y being regulated. In the next s e c t i o n of t h i s paper, we d i s c u s s some of the c h a r a c t e r i s t i c s of the "new r e g u l a t i o n " that help to d i f f e r e n -



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t i a t e i t from the more t r a d i t i o n a l forms of r e g u l a t i o n . Follow i n g t h i s , we speculate b r i e f l y concerning how these c h a r a c t e r i s t i c s are l i k e l y to i n f l u e n c e the s t r a t e g i c environment w i t h i n which the t y p i c a l f i r m i n the chemicals i n d u s t r y l i k e l y f i n d s i t s e l f presently operating. Only then do we begin to hypothesize as to the e f f e c t s that r e g u l a t i o n may have upon i n n o v a t i o n i n chemicals. T h i s may seem a rather round-about approach f o r a paper whose s t a t e d purpose i s only to examine the l a s t of these topics. But there i s method to our madness. The approach j u s t o u t l i n e d r e f l e c t s our s t r o n g l y held b e l i e f t h a t i n an i n d u s t r y l i k e chemicals, the research d e c i s i o n cannot be separated mean i n g f u l l y from other s t r a t e g i c business d e c i s i o n s . Thus, i f we are to understand i n more than j u s t a s u p e r f i c i a l way how the "new r e g u l a t i o n " i s l i k e l y to a f f e c t the long-run path of i n n o v a t i o n i n the chemicals i n d u s t r y , we must f i r s t understand how i t i n f l u ences the l a r g e r environment w i t h i n which the chemicals f i r m must operate. The road we have described i s indeed somewhat round about. But, i n our o p i n i o n , there are no easy s h o r t - c u t s . The

New

Regulatory Environment

One phenomenon that has been documented and a t t r i b u t e d to the "new r e g u l a t i o n " i s the recent r a p i d r i s e i n the amount of r e g u l a t i o n . While growth i n the o v e r a l l l e v e l of r e g u l a t o r y a c t i v i t y s u r e l y impinges upon the American economy as a whole, i t does not i n and of i t s e l f imply a change i n the r e g u l a t o r y environment of any p a r t i c u l a r f i r m or even i n d u s t r y . When a new r e g u l a t o r y agency i s formed along t r a d i t i o n a l l i n e s , with i n t e r e s t l i m i t e d to a s i n g l e i n d u s t r y , r e g u l a t o r y a c t i v i t y neces s a r i l y increases but with a d i r e c t impact on only a narrow seg ment of the economy. Other firms and i n d u s t r i e s adapt i n t h e i r dealings with the newly regulated i n d u s t r y much as they do to nonregulatory changes i n t h e i r economic and s o c i a l environment. But, by and l a r g e , that i s the l i m i t of the impact on them. The chemicals i n d u s t r y has not come under the e x c l u s i v e pur view of any s i n g l e new r e g u l a t o r y agency, but i t has over the l a s t decade or so become a "regulated i n d u s t r y . " This i s not the r e s u l t of simple growth i n the l e v e l of r e g u l a t o r y a c t i v i t y , but r e f l e c t s a new r e g u l a t o r y approach. We b e l i e v e t h i s approach can be u s e f u l l y c h a r a c t e r i z e d along four dimensions: ο

The j u r i s d i c t i o n a l boundaries of the new bodies ;

regulatory

ο

The

goals these bodies are d i r e c t e d to

ο

The how

evidence they u t i l i z e i n d e c i d i n g whether s t r i n g e n t l y to r e g u l a t e ; and f i n a l l y ,

ο

The

instruments they use when they do

achieve; and

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Each of these areas could--and perhaps w i l l u l t i m a t e l y be--the subject of i t s own separate study. But i n the i n t e r e s t of brevi t y , and i n r e c o g n i t i o n of the work done by others ( f o r example, see ( 3 ) ) , we w i l l confine ourselves to a b r i e f d e s c r i p t i o n . Regulatory J u r i s d i c t i o n s . The t r a d i t i o n a l motivation f o r r e g u l a t i o n was f e a r of " n a t u r a l monopoly" or " d e s t r u c t i v e c o m p e t i t i o n " — m a r k e t behaviors perceived to threaten consumers or producers. T h i s m o t i v a t i o n was such that the " n a t u r a l " j u r i s d i c t i o n of r e g u l a t o r y a c t i v i t y was a p a r t i c u l a r i n d u s t r y or, occas i o n a l l y , a group of r e l a t e d i n d u s t r i e s (e.g., t r a n s p o r t a t i o n ) . Consequently, the regulated i n d u s t r y was u s u a l l y subject to overs i g h t and c o n t r o l by a s i n g l e r e g u l a t o r y agency authorized by a s i n g l e , comprehensive l e g i s l a t i v e or a d m i n i s t r a t i v e a c t i o n . In c o n t r a s t , the m a j o r i t y of the newer r e g u l a t o r y agencies have been mandated to r e s o l v e s o c i a l or economic problems wherever they are p e r c e i v e d to a r i s e . In some cases, the mandate has r e s u l t e d i n r e g u l a t i o n s to which a l l (or a very wide range of) i n d u s t r i e s are immediately s u b j e c t . In other cases, agencies have focused on a few i n d u s t r i e s at a time, but with the c l e a r prospect that a l l i n d u s t r i e s are p o t e n t i a l l y subject to f u t u r e action. T h i s change i n j u r i s d i c t i o n a l d e f i n i t i o n has three important i m p l i c a t i o n s f o r the f i r m : F i r s t , the f i r m cannot r e l y on a r e g u l a t o r y agency to have a well-versed understanding of the economic and s o c i a l r o l e played by i t or i t s competitors or to r e t a i n i n t e r e s t i n the i n d u s t r y or firms long enough to observe—much l e s s accept r e s p o n s i b i l i t y f o r — t h e eventual i m p l i c a t i o n s of r e g u l a t o r y a c t i o n s . Consequently, a major r e s p o n s i b i l i t y f o r a s s e s s i n g the broader i m p l i c a t i o n s of p o l i c y a c t i o n s and communicating these r e s u l t s of t h i s assessment must f a l l upon the f i r m or i n d u s t r y i t s e l f . Second, while the very e x i s t e n c e of an agency with a p a r t i c u l a r mandate (such as the p r o t e c t i o n of the environment) provides a forewarning of the general i s s u e s t h a t one day may confront the f i r m , there i s much u n c e r t a i n t y about the s p e c i f i c form these i s s u e s might take or p r e c i s e l y when or by whom they w i l l be raised. T h i r d , the f i r m must accustom i t s e l f to d e a l i n g with interagency (and sometimes even intraagency) c o n f l i c t s . I t often i s the case t h a t one r e g u l a t o r y body w i l l be t o t a l l y unaware t h a t another body i s contemplating ( o r , indeed, has already taken) an a c t i o n t h a t impacts c r u c i a l l y upon an a c t i o n t h a t the f i r s t agency i s c o n s i d e r i n g . In such cases, the f i r m f i n d s i t s e l f i n the somewhat awkward p o s i t i o n of e x p l a i n i n g to the government what the government i t s e l f i s doing. Should i t take the lead i n t r y i n g to p o i n t out such c o n f l i c t s ? Or should i t wait u n t i l an obvious c o n f l i c t develops and attempt to e x p l o i t i t to o b t a i n a more favorable d e c i s i o n from the viewpoint of the firm? The proper answer i s by no means obvious.



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Regulatory Goals. The goals of the t r a d i t i o n a l r e g u l a t o r y agencies r e q u i r e d them to assure the long-run existence of the i n d u s t r i e s (and, i n some cases, the firms) they regulated. In some i n s t a n c e s , a promotional r e s p o n s i b i l i t y was d i r e c t l y w r i t t e n i n t o the s t a t u t e e s t a b l i s h i n g the agency. But even where t h i s d i d not occur, the goal of a s s u r i n g i n d u s t r y h e a l t h was i m p l i c i t . How could the FCC and the s t a t e PUCs assure that adequate telephone s e r v i c e was u n i v e r s a l l y a v a i l a b l e at " f a i r " rates and charges i f no company e x i s t e d to provide i t ? The same cannot g e n e r a l l y be s a i d f o r the new r e g u l a t o r y agencies. EPA's goal i s to prevent damage to the environment. I t does so by l i m i t i n g emissions deemed harmful. I t s success i n t h i s does not r e q u i r e the s u r v i v a l of the f i r m doing the emitting. The Consumer Product Safety Commission's goal i s to e l i m i n a t e hazardous products from the marketplace. Achievement of t h i s goal may sometimes r e q u i r e the e l i m i n a t i o n of the f i r m t h a t produces the products deemed hazardous. OSHA must p r o t e c t the h e a l t h and s a f e t y of workers. I f t h i s goal cannot be achieved c o n s i s t e n t with the p r e s e r v a t i o n of firms determined to be employing the unsafe p r a c t i c e s , the agency i s prepared to s a c r i f i c e such f i r m s . To a degree, Congress has recognized the d i f f i c u l t i e s inherent i n such mandates, and has placed l i m i t s on them. But these l i m i t s are n e c e s s a r i l y vague. Thus, the W i l l i a m s - S t e i g e r Occupational Health and Safety Act of 1976 r e q u i r e s the S e c r e t a r y of Labor i n promulgating standards d e a l i n g with t o x i c m a t e r i a l s or harmful p h y s i c a l agents to " . . . s e t the standards which most adequately assure, to the extent f e a s i b l e . . . t h a t no employee w i l l s u f f e r m a t e r i a l impairment of h e a l t h or f u n c t i o n a l c a p a c i t y even i f such employee has r e g u l a r exposure to the hazard d e a l t with by such standard f o r the p e r i o d of h i s working l i f e . " ( 4 ) The c o u r t s , i n i n t e r p r e t i n g t h i s mandate, have h e l d t h a t under t h i s p r o v i s i o n , a standard which i s " p r o h i b i t i v e l y expensive" i s not " f e a s i b l e . " However, standards may be deemed " f e a s i b l e " even though, from the standpoint of employers, they are f i n a n c i a l l y burdensome and a f f e c t p r o f i t margins adversely. More import a n t l y , to meet the t e s t of " f e a s i b i l i t y , " a standard does not n e c e s s a r i l y need to guarantee the continued existence of i n d i v i dual employers.(5) The Evidence on Which Regulatory Decisions Are Based. While the i s s u e s d e a l t with by the t r a d i t i o n a l r e g u l a t o r y bodies have been l a r g e l y f i n a n c i a l or commercial i n c h a r a c t e r , those faced by the "new r e g u l a t o r s " g e n e r a l l y have been more of a s c i e n t i f i c or t e c h n i c a l nature. In keeping with the s o r t of questions addressed by s c i e n t i s t s or engineers, these i s s u e s have been subj e c t to a high degree of s p e c u l a t i o n and u n c e r t a i n t y . The need to make d e c i s i o n s i n v o l v i n g such s l i p p e r y matters, and the standards and evidence upon which such d e c i s i o n s have been based,



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have d i s t r e s s e d both businessmen being regulated and c e r t a i n s c i e n t i s t s who f e a r the i n t r u s i o n of p o l i t i c s i n t o t h e i r "communi t y of s c i e n c e . " (See (6).) While exceptions can be c i t e d , by and l a r g e i t appears that the r e g u l a t o r y agencies are d e a l i n g with such i s s u e s e x a c t l y as Congress intended when i t e s t a b l i s h e d them. The u n c e r t a i n nature of many of the hazards t h a t were to be c o n t r o l l e d was recognized by Congress. The ambiguity of much of the evidence on which d e c i s i o n s i n e v i t a b l y would have to be based was admitted. But the r i s k s of w a i t i n g u n t i l a l l the evidence was i n was f e l t to outweigh the harm caused by an o c c a s i o n a l unnecessary r e g u l a t i o n . Thus, although the EPA Administrator i s d i r e c t e d to conduct s t u dies concerning the nature of the t h r e a t to the ozone l a y e r from fluorocarbons, to c o n s u l t with recognized s c i e n t i f i c a u t h o r i t i e s , and to "consider" f e a s i b i l i t y and economic impact, the f i n a l d e c i s i o n about whether and how s t r i n g e n t l y to c o n t r o l these substances r e s t s squarely on h i s shoulders. The standard he i s to use? Whether " i n h i s judgment" such substances may "reasonably" be a n t i c i p a t e d to a f f e c t the stratosphere and whether that e f f e c t , i n t u r n , "...may reasonably be a n t i c i p a t e d to endanger p u b l i c h e a l t h and welfare."(7) This i s not to suggest that the i n s t i t u t i o n s which we u t i l i z e to c o l l e c t , assess, and update s c i e n t i f i c and t e c h n i c a l i n f o r m a t i o n could not be v a s t l y improved. Our p o i n t i s t h a t the nature of the d e c i s i o n s the "new r e g u l a t o r s " are required by law to make are such as to preclude absolute c e r t a i n t y p r i o r to action. This i s l i k e l y always to be the case. Regulatory Instruments. The f o u r t h area i n which the new r e g u l a t i o n represents a break with t r a d i t i o n i s i n the i n s t r u ments i t uses to achieve i t s aims. O l d - l i n e r e g u l a t o r y agencies such as the ICC, FCC, or CAB r e l i e d p r i m a r i l y on t h e i r power to approve or disapprove s p e c i f i c requests r e l a t i n g to such matters as p r i c i n g , entry and e x i t , and mergers. But t h e i r power to i n f l u e n c e s p e c i f i c f i r m conduct was s e v e r e l y constrained by s t a t u t e . For example, the F e d e r a l A v i a t i o n Act s t a t e s : "No term, c o n d i t i o n , or l i m i t a t i o n of a [an a i r c a r r i e r ' s ] c e r t i f i c a t e [of p u b l i c convenience and n e c e s s i t y - - t h e operating l i c e n s e i s s u e d by the CAB] s h a l l r e s t r i c t the r i g h t of an a i r c a r r i e r to add to or change schedules, equipment, accommodations, or f a c i l i t i e s f o r performing the authorized t r a n s p o r t a t i o n and s e r v i c e as the development of the business and the demands of the p u b l i c s h a l l require..."(8) The " q u a s i - r e g u l a t o r s " such as the A n t i t r u s t D i v i s i o n have always employed a combination of s p e c i f i c enforcement a c t i o n s i n the courts with statements of general p o l i c y i n t h e i r attempt to a l t e r the general p a t t e r n of business conduct. They, too, l e f t the d e t a i l e d day-to-day d e c i s i o n s concerning what a f i r m might produce and how to produce i t to the d i s c r e t i o n of the f i r m and i t s management. In c o n t r a s t to the p r o h i b i t i o n s c i t e d above on


7


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p e r m i s s i b l e CAB c o n t r o l instruments, EPA, OSHA, and CPSC can (and do) d i c t a t e the most minute d e t a i l s of how a production process s h a l l be c a r r i e d out, what i n p u t s , outputs, and intermediate products w i l l r e s u l t , and what the p r e c i s e c h a r a c t e r i s t i c s and uses of the f i n a l product w i l l be. Of course, such a c t i v i t i e s r e q u i r e the new r e g u l a t o r s to know things they do not--and l i k e l y even cannot—know about the d e t a i l s of i n d i v i d u a l f i r m s ' operations. They are not unaware of t h a t . But they s t r u g g l e on anyway. The four c h a r a c t e r i s t i c s of the "new r e g u l a t i o n " we have j u s t described combine to produce a major change i n the s t r a t e g i c environment f a c i n g the t y p i c a l l a r g e business f i r m today. How t h i s happens, and what i t means f o r the f i r m i s the t o p i c to which we now t u r n . Impact on the S t r a t e g i c Decisionmaking Environment of the

Firm

In recent years, the question of whether the United States should engage i n something c a l l e d "economic planning" has generated considerable controversy with conservatives g e n e r a l l y condemning and l i b e r a l s g e n e r a l l y applauding the i d e a . However, the p i c t u r e that emerges from the above d e s c r i p t i o n of the "new regul a t i o n " i n d i c a t e s t h a t , i n a r e a l sense, the debate has been s e t tled. As f e d e r a l r e g u l a t i o n has g r a d u a l l y come to a f f e c t more and more areas of the t y p i c a l firm's a c t i v i t i e s , the government has acquired more a u t h o r i t y to i n f l u e n c e f i r m decisionmaking than l i k e l y would have been t o l e r a t e d had t h i s country adopted an e x p l i c i t system of n a t i o n a l planning. But while the a b i l i t y to i n f l u e n c e i s now present, the a b i l i t y to comprehend the e f f e c t s of a c t u a l and proposed a c t i o n s and to coordinate the v a r i o u s d i f f e r e n t a c t i v i t i e s being undertaken i s l a r g e l y absent. In i t s current s t a t e , the government r e g u l a t o r y apparatus i s l i k e a benevolent, w e l l - i n t e n t i o n e d g i a n t , s t r u g g l i n g to do good, but o f t e n wreaking havoc due to i t s sheer s i z e and power, i t s l a c k of the necessary sensory and feedback mechanisms, and i t s only p a r t i a l l y developed b r a i n . We w i l l leave i t to others to debate whether such an organism can ever e i t h e r l e a r n to c o n t r o l i t s e l f or be brought under e f f e c t i v e e x t e r n a l c o n t r o l . Instead, we w i l l confine our a t t e n t i o n here to d i s c u s s i n g how having to l i v e with such a s t a t e of a f f a i r s i s l i k e l y to i n f l u e n c e the s t r a t e g i c environment w i t h i n which the f i r m must operate c e r t a i n l y at present and perhaps i n d e f i n i t e l y i n t o the f u t u r e . In the past, the p r i n c i p a l f a c t o r s t h a t a businessman had to take i n t o account when p l o t t i n g a future course of a c t i v i t y f o r h i s f i r m were the a t t i t u d e of the p u b l i c toward h i s products and the l i k e l y a c t i o n s and r e a c t i o n s of a c t u a l and p o t e n t i a l competitors. I f he chose to engage i n research and development, he added a t h i r d category of w o r r i e s — t h e p o s s i b i l i t y that nature might prove f i c k l e and prevent h i s s c i e n t i s t s and engineers from developing the new products and processes upon which h i s plans



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depended. The i n t r o d u c t i o n of r e g u l a t i o n — i n p a r t i c u l a r , multi-agency, issue-oriented regulation—changes the businessman's d e c i s i o n making c a l c u l u s . This change i s not brought about so much from the burden o f having to spend time d e a l i n g with numerous government agencies. This aspect of r e g u l a t i o n i s a c c u r a t e l y d e s c r i b a b l e as a "hidden tax" and, as such, can be adjusted to r e l a t i v e l y simply. No, the "new r e g u l a t i o n " i s much more than merely a "hidden tax." Due to the c h a r a c t e r i s t i c s i d e n t i f i e d above, i t i s the generator of a c l a s s o f u n c e r t a i n t i e s q u i t e d i f f e r e n t i n nature from those with which the businessman has h i s t o r i c a l l y been accustomed to d e a l i n g . Because government r e g u l a t o r y a c t i v i t i e s are so uncoordinated, i t i s d i f f i c u l t , i f not impossible, f o r a businessman to know what the government's p r i o r i t i e s are i n r e g u l a t i n g . Most l e g i s l a t i o n speaks i n absolutes. Workers w i l l be p r o t e c t e d . The environment w i l l be preserved. Energy w i l l be conserved. Consumer products w i l l be s a f e . But when c o n f l i c t s develop, as they i n e v i t a b l y must, which goal i s to have p r i o r i t y ? As new goals are d e f i n e d , how are c o n f l i c t s with o l d e r goals to be r e c o n c i l e d ? And as i t becomes c l e a r t h a t the absolutes sought by the law are unreachable, how are the necessary compromises to be developed? Businessmen ask, "Doesn't the government know what i t wants?" The answer i s "no," p r i m a r i l y because, as f a r as r e g u l a t i o n i s concerned, there i s no s i n g l e a c t o r t h a t can be c a l l e d "the government." Even more confusing to businessmen i s the matter o f how s p e c i f i c t a r g e t s f o r r e g u l a t o r y a t t e n t i o n are s e l e c t e d . The wide l a t i t u d e o f d i s c r e t i o n given agency a d m i n i s t r a t o r s , the vague nature of t h e i r mandates, and the u n c e r t a i n nature o f the e v i dence with which they have to deal i n e v i t a b l y leads to a c t i o n s t h a t seem (and sometimes are) h i g h l y a r b i t r a r y . Indeed, the agencies' poor understanding o f the i n d u s t r i e s they regulate means that they are o f t e n as s u r p r i s e d as the businessman being regulated to f i n d t h a t a p a r t i c u l a r c l a s s o f firms w i l l be impacted by what they are proposing to do. F i n a l l y , the almost u n i v e r s a l use o f "command and c o n t r o l " techniques f o r enforcement once standards have been decided upon helps insure t h a t u l t i m a t e r e g u l a t o r y outcomes w i l l be u n c e r t a i n . The s t r i n g e n c y , t i m i n g , and even a p p l i c a b i l i t y o f r e g u l a t i o n s to a p a r t i c u l a r f i r m or even to e n t i r e c l a s s e s of firms i s o f t e n i n doubt u n t i l lengthy court b a t t l e s have taken p l a c e . To be sure, business i t s e l f i s the i n s t i g a t o r o f much o f t h i s p r o t r a c t e d litigation. But the u n c e r t a i n t y t h i s process generates i n the minds o f top executives, stockholders, customers, the firm's bankers, and employees cannot help but p l a y havoc with a firm's a b i l i t y to plan r a t i o n a l l y .



10


But the p i c t u r e may not be a l l t h a t bleak, a t l e a s t from the viewpoint of the i n d i v i d u a l f i r m . The very f a c t t h a t government agencies are u s u a l l y uninformed about the i n d u s t r i e s they regul a t e , t h a t t h e i r p r i o r i t i e s and procedures f o r t a r g e t i n g are so i l l d e f i n e d , and that t h e i r enforcement processes so a r b i t r a r y creates major o p p o r t u n i t i e s f o r the r e g u l a t o r y process to be i n f l u e n c e d to the advantage of the f i r m . The use of the r e g u l a t o r y process by " p u b l i c i n t e r e s t " groups to achieve t h e i r goals has been w e l l documented. (See, f o r example, (9).) Less w e l l known or understood i s i t s use by i n d i v i d u a l business firms to create or enhance the market f o r t h e i r products or to disadvantage a competitor. The b e n e f i t s can be s u b s t a n t i a l . In a recent a r t i c l e , Fortune magazine estimated the s u b s i d i e s created by Congress f o r small r e f i n e r s through the o i l e n t i t l e m e n t s program at $2.5 b i l l i o n per year.(10) T h i s , p l u s the f a c t that the magnitude of the p e r - b a r r e l subsidy i s i n v e r s e l y p r o p o r t i o n a l to the s i z e of the r e f i n e r y , has caused a boom i n the c o n s t r u c t i o n of otherwise highly i n e f f i c i e n t units. Jackson and Leone, i n a soon-to-bep u b l i s h e d paper, estimate the impact on i n d i v i d u a l establishments i n segments of the pulp and paper i n d u s t r y of the 1972 Amendments to the Water P o l l u t i o n C o n t r o l A c t . ( _ l l ) Observing that the magnitude of the cost pass-through w i l l be determined by the impact on the average f i r m , they observe t h a t some firms stand to have t h e i r p r o f i t s s u b s t a n t i a l l y enhanced. We have encountered s i m i l a r examples i n our present study f o r EPA of the economic impact of p o t e n t i a l c o n t r o l s over nonaerosol f l u o r o c a r b o n emissions. As disadvantaged as c e r t a i n firms might be by such c o n t r o l s , others stand to p r o f i t handsomely by them. Indeed, t h i s a b i l i t y to p r o f i t from the c u r r e n t c h a o t i c s t a t e of the r e g u l a t o r y process has been suggested by some as a reason why businessmen, who might otherwise seem the n a t u r a l a l l i e s of the i n c r e a s e d use of more p r e d i c t a b l e economic i n c e n t i v e s , adamantly defend current r e g u l a t o r y techniques.(12) The range of p e r m i s s i b l e conduct open to a f i r m i n attempting to i n f l u e n c e governmental r e g u l a t o r y a c t i v i t i e s i s much broader than when engaging i n more t r a d i t i o n a l forms of competition. A businessman cannot conspire w i t h h i s competitor to r a i s e or lower p r i c e s . He cannot engage i n o v e r t l y predatory behavior. He cannot merge i f that merger w i l l tend to c r e a t e a monopoly " i n any l i n e of commerce i n any s e c t o r of the country."(13) But he can attempt to i n f l u e n c e the government to undertake a c t i o n s which have the i d e n t i c a l e f f e c t . (See (14).) Thus r e g u l a t i o n , through i t s very a r b i t r a r i n e s s and i t s susc e p t a b i l i t y to manipulation, emerges as both a major problem and a prime o p p o r t u n i t y f o r today's business f i r m . Through i t s regul a t o r y a c t i v i t i e s , government has become both a c r e a t o r and dest r o y e r of business o p p o r t u n i t i e s , a f a c t o r equal i f not s u p e r i o r i n importance to the a c t i o n s of competitors and the t a s t e s of the p u b l i c i n shaping corporate s t r a t e g y . T r a c i n g out the


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i m p l i c a t i o n s of t h i s f a c t i s a task deserving of a t t e n t i o n . But t h i s must be the subject of another paper. Instead l e t us at long l a s t address the question we o r i g i n a l l y posed: How does t h i s "new r e g u l a t i o n " and the f a c t t h a t i t c o n s t i t u t e s such a change i n the firm's competitive environment a f f e c t the firm's i n c e n t i v e and a b i l i t y to innovate?


The Impact of the "New Hypotheses

Regulation"

on Innovation:

Some T e n t a t i v e

While others undoubtedly could be suggested, we have i d e n t i f i e d f i v e impacts that r e g u l a t i o n as we have described i t can have on i n n o v a t i o n f o r a t y p i c a l l a r g e chemicals f i r m : ο

Regulation may d i v e r t resources be used to fund research.

ο

Regulation may change the firm's a b i l i t y to c a l c u l a t e the p a y o f f s to investments i n research and development.

ο

Regulation may a l t e r the p r o p o r t i o n of b e n e f i t s that are p r o p e r l y c l a s s i f i a b l e (from the viewpoint of the firm) as " e x t e r n a l i t i e s , " and t h i s may change the nature of research the f i r m i s l i k e l y to undertake.

ο

Regulation may change the optimal i n s t i t u t i o n a l pat terns f o r performing c e r t a i n types of research.

ο

Regulation

may

that otherwise might

p o l i t i c i z e the research

process.

Although some might consider us e x c e s s i v e l y t i m i d , we h e s i t a t e at t h i s p o i n t to d e c l a r e whether, on balance and i n the longer-term, these v a r i o u s impacts are l i k e l y to increase or decrease the i n c e n t i v e of the chemicals f i r m to innovate and thus the l e v e l of funding t h a t w i l l be devoted to research and development a c t i v i t i e s . We do b e l i e v e t h a t r e g u l a t i o n c e r t a i n l y w i l l a l t e r both the r o l e research p l a y s i n the f i r m and the manner i n which the firm's research a c t i v i t y f u n c t i o n s . There f o r e , r a t h e r than devote much time to s p e c u l a t i n g about f u t u r e l e v e l s of research spending i n chemicals, we w i l l content our selves with o u t l i n i n g i n a s e m i - a n a l y t i c a l f a s h i o n the v a r i o u s impacts we have mentioned, r e s e r v i n g the more q u a n t i t a t i v e con c l u s i o n s u n t i l our research i s more complete. D i v e r s i o n of Resources. We have already noted that t h i s i s the aspect of r e g u l a t i o n ' s impact on research a c t i v i t y i n the chemicals i n d u s t r y that has been most widely discussed. Com panies t h a t r e p o r t l a r g e shares of t h e i r current resources being devoted to responding to government requests f o r i n f o r m a t i o n and



12


to complying with r e g u l a t i o n s t h a t have a l r e a d y been promulgated i n f e r ( i f they don't d i r e c t l y s t a t e ) t h a t some p o r t i o n o f these funds would otherwise have been d i r e c t e d to i n c r e a s e d expenditures on " p r o d u c t i v e " research and development. The impact o f t h i s "resource d i v e r s i o n " argument on the firm's research and development a c t i v i t i e s would be g r e a t e s t i f , as some c l a i m , the l e v e l of resources devoted to R&D were gene r a l l y a simple f u n c t i o n o f net earnings. C e r t a i n l y some firms take t h i s "consumption" view o f R&D. But, i f we are to b e l i e v e the r e s u l t s o f those who have s t u d i e d the i n n o v a t i o n process, the v a s t m a j o r i t y o f firms view R&D as an investment. In such a case, the resource d i v e r s i o n aspect o f r e g u l a t i o n a f f e c t s R&D spending not because of i t s e f f e c t on c u r r e n t net earnings, but because i t a l s o promises to a f f e c t f u t u r e earnings from any new product or process developed as a r e s u l t o f a c u r r e n t expenditure of R&D funds. But note. T h i s i s e q u a l l y true f o r any investment the f i r m might make--in an a d v e r t i s i n g campaign, i n a c q u i r i n g a new s u b s i d i a r y , or i n expanding producton c a p a c i t y . To the extent t h a t the p a y o f f t o R&D occurs f u r t h e r i n the f u t u r e than the p a y o f f to other a c t i v i t i e s , or to the extent t h a t a d i f f e r e n t i a l r i s k premium i s assigned to R&D p r o j e c t s , R&D spending might be p a r t i c u l a r l y hard h i t . But the net r e s u l t on the firm's a l l o c a t i o n of f u t u r e resources across i t s f u l l spectrum o f f u t u r e o p p o r t u n i t i e s i s not a l l t h a t c l e a r . For example, i n a world o f rampant r e g u l a t i o n where research can serve both to generate r e g u l a t o r y t a r g e t s and to provide perhaps the most e f f e c t i v e r e g u l a t o r y defense, the short-term p a y o f f to investment i n c e r t a i n types o f research may be immense. Consider fluorocarbons and products r e l a t e d to them. I f a l l a f f e c t e d i n d u s t r i e s are i n c l u d e d , tens or even hundreds o f b i l l i o n s o f d o l l a r s i n s a l e s are l i k e l y to be a f f e c t e d by whatever the u l t i m a t e r e g u l a t o r y d e c i s i o n i s . The magnitude o f these costs w i l l s u r e l y p l a y some r o l e i n determining the a c t i o n t h a t i s taken. But the d r i v i n g f a c t o r w i l l be the s t a t e o f informat i o n a t the time a d e c i s i o n i s made concerning the ozonefluorocarbon r e l a t i o n s h i p . Research to develop new uses f o r fluorocarbons may be i n limbo pending r e s o l u t i o n o f the f l u o r o carbon i s s u e . But research to i n v e s t i g a t e the u n d e r l y i n g atmosp h e r i c r e l a t i o n s h i p s , techniques f o r f l u o r o c a r b o n c o n s e r v a t i o n , and s u b s t i t u t e r e f r i g e r a n t s , blowing agents, a e r o s o l p r o p e l l a n t s , etc., has been g r e a t l y s t i m u l a t e d . Much o f t h i s research may appear (and even may be) "unproductive" from the viewpoint o f those firms who had other plans f o r the resources and personnel now i n v o l v e d i n i t . And i t c e r t a i n l y i s not the r e s u l t o f any well-planned or l o g i c a l l y conceived s t r a t e g y that i d e n t i f i e d t h i s as an area where concentrated s c i e n t i f i c i n q u i r y might y i e l d e s p e c i a l l y promising r e s u l t s a t t h i s time. But i t n e v e r t h e l e s s i s going on. And, i n e v i t a b l y , i t w i l l y i e l d new product ideas t h a t can be e x p l o i t e d by someone (but perhaps not the firms cond u c t i n g the research) a t some f u t u r e date.



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The one area where R&D spending might most be expected to be impacted would be b a s i c research, since the b e n e f i t s of such research are, by d e f i n i t i o n , undefinable at the time the research i s c a r r i e d out. I n d i v i d u a l s who have s t u d i e d f i r m behavior report t h a t , i n t h i s i n s t a n c e , a l l o c a t i o n of funds are o f t e n decided on a " r u l e of thumb" b a s i s . This i s not too r e l e v a n t a c o n s i d e r a t i o n i n the case of chemicals research, f o r most chemi c a l s firms conduct l i t t l e of what i s p r o p e r l y termed " b a s i c research." Mansfield's survey of seven major chemicals research l a b o r a t o r i e s showed that i n 1966, only 7 percent of expenditures were f o r t h i s research category.(15) And indeed, i t could be argued t h a t a p r i v a t e f i r m has l i t t l e or no business engaging i n such a c t i v i t i e s . (See (16). This suggests that the 7 percent f i g u r e c i t e d above f o r chemicals i n d u s t r y " b a s i c research" may be overstated.) However, as we w i l l observe below, there are reasons to b e l i e v e that r e g u l a t i o n may be a c t i n g to increase the incen t i v e f o r chemicals firms to engage i n what otherwise would be considered " b a s i c research," by changing i t s character so t h a t i t does promise to produce an i d e n t i f i a b l e payoff to the f i r m . Changes i n the A b i l i t y of Firms to C a l c u l a t e Payoffs from Research. As we have already mentioned, most firms appear to consider t h e i r R&D expenditures to c o n s t i t u t e investments designed to generate f u t u r e streams of income. As such, t h e i r research d e c i s i o n s must meet the t e s t of any investment--the discounted present value of t h e i r a n t i c i p a t e d f u t u r e revenues must exceed the discounted present value of t h e i r f u t u r e c o s t s . However, investments i n research and development are charac t e r i z e d by s p e c i a l r i s k s . F i r s t there i s the r i s k t h a t the t e c h n i c a l o b j e c t i v e sought w i l l not be achieved. Then there i s the r i s k that the product or process cannot be p r o f i t a b l y mark eted. Mansfield's work makes c l e a r t h a t the l a t t e r are g e n e r a l l y more important than the former (due i n p a r t perhaps to the small t e c h n i c a l advances t y p i c a l l y sought i n i n d u s t r i a l research pro j e c t s ) but t h a t taken together, these r i s k s are high. (Mansfield s t u d i e d three i n d u s t r i a l l a b o r a t o r i e s , one chemi c a l s and two p r o p r i e t a r y drug. He found that 40 percent of the R&D p r o j e c t s t h a t were begun were not t e c h n i c a l l y completed; of those t h a t were t e c h n i c a l l y completed, 45 percent were not com m e r c i a l i z e d , presumably because of poor commercial prospects; and of those that were commercialized, 60 percent d i d not earn an economic p r o f i t value that i s defined as a r e t u r n exceeding t h a t a v a i l a b l e from a l t e r n a t e uses of funds.(17) Thus the p r o b a b i l i t y that a given p r o j e c t , once s t a r t e d , would be t e c h n i c a l l y success f u l , commercialized, and p r o f i t a b l e was 0.6 χ 0.55 χ 0.4 = 0.13.)



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R e g u l a t i o n may a l t e r these r i s k s . In determining whether research aimed at producing a new product can be deemed to have achieved " t e c h n i c a l success" and the r e s u l t i n g product considered p o t e n t i a l l y "commercializable," a t t e n t i o n must now be given to whether the product can meet both c u r r e n t and a n t i c i p a t e d t e s t s for t o x i c i t y , c a r c i n o g e n i c i t y , mutagenicity, t e r a t o g e n i c i t y , e t c . L i k e the costs of r e g u l a t o r y paperwork, t h i s burden i s not too d i f f i c u l t f o r the f i r m to d e a l with. The cost of the t e s t s are w e l l known. And, i f they are at a l l " a p p r o p r i a t e , " the products that are screened out are those t h a t had no business being advanced to the next stage of development. I f the t e s t s are " i n a p p r o p r i a t e , " but s t i l l serve a screening f u n c t i o n t h a t regul a t o r y a u t h o r i t i e s and the courts consider adequate, only the p u b l i c i s the l o s e r . The f i r m ' s p r o f i t s are l i k e l y to be r e l a t i v e l y unaffected. However, a product can meet the conventional standards f o r "commercialization" and "pass" the b a t t e r y of t e s t s j u s t r e f e r r e d to and s t i l l run i n t o t r o u b l e . A corporate decisionmaker, aware of recent h i s t o r y and knowledgeable of the present somewhat confused s t a t e of chemicals r e g u l a t i o n , must consider the r e a l poss i b i l i t y t h a t , i f he proceeds to a u t h o r i z e steps l e a d i n g to comm e r c i a l i z a t i o n , somewhere down the road a new and c u r r e n t l y undreamed-of hazard w i l l be i d e n t i f i e d t h a t w i l l l e a d to severe r e s t r i c t i o n s being p l a c e d on the m a r k e t a b i l i t y of h i s product. This may represent the g r e a t e s t hurdle of a l l to new product development, f o r as expensive as the e a r l y stages of the product development process (and even t o x i c i t y t e s t i n g ) undoubtedly are, the r e a l costs of b r i n g i n g a new product to the marketplace only begin once the d e c i s i o n i s made to move i t out of the l a b . Mansf i e l d has estimated t h a t , f o r chemicals, 83 percent of the costs of new product development occur a f t e r the a p p l i e d research stage and 57 percent occur even a f t e r the p i l o t p l a n t stage.(18) I t i s d i f f i c u l t to know how t h i s l a t t e r category of r i s k s can be d e a l t with by a decisionmaker. C e r t a i n l y increased t e s t ing of a l l new chemicals i s one reasonable response. We are not s u r p r i s e d to l e a r n t h a t at l e a s t one company i s c o n s i d e r i n g a l l new chemicals to be p o t e n t i a l l y t o x i c and i s s u b j e c t i n g them to i n t e n s i v e screening. (See (19). Indeed, t h i s seems to be the path d i c t a t e d by the T o x i c Substances C o n t r o l Act.) However, as we have a l r e a d y suggested, t h i s response, while perhaps laudable, is insufficient. Accepted standards of t o x i c i t y change.(See, f o r example, (20). T h i s t e s t may seem h o p e l e s s l y p r i m i t i v e today, but c o n s i d e r i n g the advances i n s c i e n c e , who i s to say t h a t 30 years from now our c u r r e n t t e s t i n g methods won't be considered e q u a l l y p r i m i t i v e . ) Furthermore, c e r t a i n hazards are so remotely a s s o c i a t e d with a given chemical t h a t no conceivable t e s t made at the time of the commercialization d e c i s i o n was being made could hope to d i s c o v e r them. The example of f l u o r o c a r b o n s ' hypothesized impact on the ozone l a y e r i s as good as any to c i t e here.



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What, then, i s the c o n s c i e n t i o u s executive to do? The most reasonable course f o r him would be to employ a heavy a d d i t i o n a l r i s k premium when e v a l u a t i n g any chemical that meets a l l p r e s e n t l y known t e s t s and t h a t shows strong commercial p o t e n t i a l . I f the product passes even t h i s hurdle, i t may s t i l l e v e n t u a l l y encounter r e g u l a t o r y d i f f i c u l t i e s , but the chances are high that i t w i l l have r e p a i d i t s development cost and produced a p r o f i t f o r the company by the time these d i f f i c u l t i e s emerge. The impact of such a " r e g u l a t o r y r i s k premium" would be to s l o w — b u t not n e c e s s a r i l y stop—new product development. A l t e r n a t i v e l y , the decisionmaker might impose a moratorium on commercializing new products. This might prove s u p e r i o r when the r e g u l a t o r y s i t u a t i o n i s i n a s t a t e of extreme f l u x and i s expected to s t a b i l i z e . In such a case, the appropriate r i s k premium might be so high t h a t the knowledgeable executive, hoping that the s i t u a t i o n i s temporary, would be h e s i t a n t to impose i t and thereby weed out new product ideas t h a t might prove acceptable once matters s t a b i l i z e d . Casual conversations with chemical executives suggest t h a t behavior of the l a t t e r s o r t may be o c c u r r i n g at present. But absent systematic i n v e s t i g a t i o n , we h e s i t a t e to give much weight to such statements. C e r t a i n l y t h i s i s a time of extreme r e g u l a tory uncertainty. Passage of l e g i s l a t i o n such as the Toxic Substances C o n t r o l Act r e f l e c t s Congress' f e e l i n g s t h a t some form of r e g u l a t o r y screening procedures i s a b s o l u t e l y necessary i f s e n s i b l e product i n t r o d u c t i o n d e c i s i o n s are ever to be made. But i t remains to be seen whether the l e g i s l a t i o n w i l l produce any increase i n p r e d i c t a b i l i t y or, more importantly, whether generali z a b l e procedures w i l l emerge that permit e x i s t i n g chemicals to be c l a s s i f i e d as to p o t e n t i a l t h r e a t . The preceding two c a t e g o r i e s of impacts have p r e v i o u s l y been i d e n t i f i e d and t h e i r s i g n i f i c a n c e widely debated. The next three we w i l l mention have been much l e s s discussed but are, i n our view, of even greater long-term importance. Changes i n the Nature of Research t h a t Firms Undertake. The mention above of the importance of developing g e n e r a l i z a b l e t e s t ing procedures f o r chemicals gets us to the t h i r d of the e f f e c t s that r e g u l a t i o n l i k e l y i s having on chemicals r e s e a r c h — i t s impact on the nature of research that chemicals firms undertake. We noted e a r l i e r t h a t most chemicals firms do not a c t u a l l y engage i n much " b a s i c research"--that i s , research whose r e s u l t s are intended to show no apparent a p p l i c a b i l i t y to the firm's businesses. T h i s i s because such research generates no promise of p r o f i t f o r the f i r m , and i t i s promise of p r o f i t , not concern over the s t a t e of human knowledge, t h a t motivates research spending by p r i v a t e f i r m s .



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R e g u l a t i o n a l t e r s t h i s c a l c u l a t i o n by a l t e r i n g the p a y o f f s to d i f f e r e n t c l a s s e s of research. Although other examples s u r e l y can be c i t e d , the one that comes immediately to mind i s the e x p l o s i v e growth of i n d u s t r i a l i n t e r e s t i n the once obscure f i e l d of t o x i c o l o g y . I t i s a mistake to assume, as some appear t o , that chemicals firms gave no thought whatever to the p o s s i b l e consequences to the environment, to consumers, or to workers r e s u l t i n g from the p r o d u c t i o n or use of t h e i r products p r i o r to the r i s e of the "new r e g u l a t i o n . " L e g a l d o c t r i n e s of l i a b i l i t y , although perhaps not as s t r i c t then as today, provided such an i n c e n t i v e as d i d concern f o r the company's p u b l i c image. (Remember the slogan " B e t t e r things f o r b e t t e r l i v i n g through chemistry"?) But there can be no doubt that the r i s e of the "new r e g u l a t i o n " and, i n p a r t i c u l a r , c e r t a i n of i t s c h a r a c t e r i s t i c s mentioned e a r l i e r , have g r e a t l y s t i m u l a t e d t o x i c o l o g i c a l research. The reasons are complex r e f l e c t i n g the complexity of the i n c e n t i v e s p r e s e n t l y generated by chemicals r e g u l a t i o n . In p a r t they are d e f e n s i v e . Chemicals f i r m s , perhaps once content to draw much of t h e i r b a s i c research from the u n i v e r s i t i e s , now want to stay abreast of r e s e a r c h that can overnight d i r e c t the r e g u l a t o r y s p o t l i g h t at important segments of t h e i r business. Given the nature of the a d v e r s a r i a l process, they cannot wait u n t i l a research r e s u l t i s p u b l i s h e d i n a reputable s c i e n t i f i c j o u r n a l and subjected to c r i t i c a l s c r u t i n i z i n g by d i s i n t e r e s t e d c o l leagues . In p a r t , however, the reasons f o r i n t e r e s t i n t o x i c o l o g y may r e f l e c t the power that such knowledge can give a f i r m v i s - a - v i s i t s competitors. Although i n d i v i d u a l firms w i l l deny t h a t they engage i n such behavior, i t i s not unknown f o r firms to boost t h e i r own prospects by suggesting t h a t a competitor's product may embody c e r t a i n dangers. F i n a l l y , research on t o x i c o l o g y may u l t i m a t e l y generate a l e v e l of understanding about the e f f e c t s of chemicals on b i o l o g i c a l processes s u f f i c i e n t to permit the development of the gene r a l i z a b l e t e s t i n g procedures mentioned e a r l i e r . From the viewpoint of the chemicals i n d u s t r y , t h i s would be a great boon, j u s t i f y i n g the expenditure of c o n s i d e r a b l e sums of money on research whose immediate a p p l i c a b i l i t y appears u n c e r t a i n . Changes i n the Optimal I n s t i t u t i o n s f o r Performing Research. The same f a c t o r s which a l t e r the type of research that the f i r m has an i n c e n t i v e to undertake a l s o a l t e r the i n s t i t u t i o n a l form w i t h i n which that research may o p t i m a l l y be c a r r i e d out. L a s t year, major chemicals firms announced the establishment of an industry-funded i n s t i t u t e to undertake research on t o x i c o l o g y . ( 2 1 ) T h i s represents a sharp break f o r the chemicals i n d u s t r y which t r a d i t i o n a l l y has r e l i e d most h e a v i l y on in-house research c a p a b i l i t y . I t seems explanable i n p a r t because of the s h i f t i n what i s p r o p e r l y c l a s s i f i a b l e from the viewpoint of the


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f i r m as " b a s i c research." But more may be i n v o l v e d . There are strong competitive reasons why i t i s u s e f u l that a l l chemicals firms have equal access to any breakthroughs t h a t might be made i n i d e n t i f y i n g new c l a s s e s o f t o x i c substances or new mechanisms by which t o x i c i t y might be i n f e r r e d . Such breakthroughs may " c l e a r " e n t i r e groups of chemicals or p l a c e others i n jeopardy. I t makes good sense from the viewpoint o f the chemicals i n d u s t r y to fund such work c o o p e r a t i v e l y . We are l e s s c e r t a i n that i t i s i n the p u b l i c i n t e r e s t , but leave that question to f u t u r e research. The Transformation o f Research i n t o an A d v e r s a r i a l Process. Regulation, and the increased a t t e n t i o n i t has focused on hazards to the environment, to consumers, and t o workers, has a l t e r e d the once p r e v a l e n t view o f the researcher as a d i s p a s s i o n a t e s c h o l a r , g r a d u a l l y developing a l i n e o f i n q u i r y , p u b l i s h i n g only f o r the b e n e f i t o f h i s colleagues and i n the name o f advancing the s t a t e of human knowledge. This p i c t u r e probably was never completely accurate, even i n the academic world. I t c e r t a i n l y never charact e r i z e d i n d u s t r i a l research. Nevertheless, the r i s e o f s c i e n t i f i c a c t i v i s m has g r e a t l y a l t e r e d the nature of s c i e n t i f i c inquiry. (See (22).) The a b i l i t y (and w i l l i n g n e s s ) o f r e g u l a t o r y bodies to reach i n t o firms t o gain access to p r e l i m i n a r y research f i n d i n g s , and the n e c e s s i t y t h a t corporate researchers be w i l l i n g to defend t h e i r work to the general p u b l i c , not j u s t to t h e i r s u p e r i o r s , i s l i k e l y t o change the nature o f the research process as w e l l as the type o f i n d i v i d u a l who seeks out a career i n i n d u s t r y . Changes such as these are l i k e l y to be the most d i f f i c u l t o f a l l to v e r i f y , but, i n the long run, may prove to be the most s i g n i f i c a n t , both f o r the f i r m and the economy. Conclusion Much has been heard o f l a t e concerning the impact of r e g u l a t i o n on i n d u s t r i a l i n n o v a t i o n . A consensus seems t o be emerging that t h i s impact has been negative and t h a t , as a consequence, the "burden" o f r e g u l a t i o n should be eased. While we would agree that there i s s u b s t a n t i a l room f o r improvement i n the way our government regulates business conduct, we hope t h a t t h i s paper makes c l e a r that we are s k e p t i c a l of many o f the claims that have been put forward t o d a t e — a s w e l l as of many of the proposed " s o l u t i o n s . " Regulation i s indeed l i k e l y t o generate major changes--not a l l o f them d e s i r a b l e from a s o c i a l p o i n t of view--in business behavior i n t h i s country. But o v e r l y s i m p l i s t i c s o l u t i o n s to o v e r l y s i m p l i f i e d c h a r a c t e r i z a t i o n s o f "the problem" w i l l not help matters. We need t o examine i n a much more systematic way than we have done i n the past j u s t what these changes w i l l be. F o r not u n t i l that has been done can we hope t o advance s o l u t i o n s that have a high p r o b a b i l i t y generating a genuine improvement.


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FEDERAL REGULATION AND CHEMICAL INNOVATION Acknowledgments

The research upon which t h i s paper i s based was supported p a r t i a l l y by The Rand C o r p o r a t i o n as p a r t of i t s program of pub l i c service. The author would l i k e to thank Adele Palmer, The Rand C o r p o r a t i o n , f o r her suggestions and h e l p f u l c r i t i c i s m s .


Literature Cited 1. Denison, Edward F., "Effects of Selected Changes i n the Institutional and Human Environment Upon Output Per Unit of Input," Survey of Current Business (January 1978), 58, (1), 21-44. 2. Chandler, Alfred D., Strategy and Structure, M.I.T. Press, Cambridge, 1962. 3. Weidenbaum, Murray L., Business, Government, and the Public, Prentice-Hall, Englewood C l i f f s , N. J., 1977. 4. 29 USCA 655(b)(5) [ i t a l i c s added]. 5. Industrial Union Department, AFL-CIO v. Hodgson, Court of Appeals, D.C. Circuit, 1974, 449 F. 2d 467. 6. Weinberg, Alvin Μ., "Science and Trans-Science," Minerva, (April 1972), 209-222. 7. 1977 Clean A i r Act Amendments, Sec. 126, inserting new Part B, Sec. 157(b) to T i t l e I of the Clean A i r Act. 8. 47 USCA 1371(e)(4). 9. Berry, Jeffrey Μ., Lobbying for the People: The P o l i t i c a l Behavior of Public Interest Groups, Princeton Univer sity Press, Princeton, 1977. 10. Alexander, Tom, "How L i t t l e O i l Hit a Gusher on Capitol Hill," Fortune, (August 14, 1978), 148-154. 11. Jackson, John E., and Leone, Robert Α., "The P o l i t i c a l Economy of Federal Regulatory Activity: A Case Study of Water Pollution Controls in the Pulp and Paper Industry," preliminary version. 12. Buchanan, J. Μ., and Tullock, G., "Polluters' Profits and P o l i t i c a l Response: Direct Controls versus Taxes," American Economic Review, (March 1975), 129-147. 13. Clayton Antitrust Act, Section 7. 14. Eastern Railroad Presidents Conference v. Noerr Motor Freight, 365 U.S. 127, 1961. 15. Mansfield, Edwin, et a l . , Research and Innovation i n the Modern Corporation, 34, Table 2.6, Norton, New York, 1971. 16. Brown, Alfred E., "New Definitions for Industrial R&D," Research Management, (September 1972), 56-57. 17. Mansfield, op. c i t . , p. 209.


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18. Mansfield, op. c i t . , p. 118. 19. Newsweek, (August 21, 1978), 27. 20. Lowrance, William W., Of Acceptable Risk, 159-160, Kaufman, Inc., Los Altos, Ca., 1976. 21. Reddig, William, "Industry's Preemptive Strike Against Cancer," Fortune, (February 13, 1978), 116-119. 22. Goodell, Rae, The Visible Scientists, L i t t l e , Brown, and Company, Boston, 1975.

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Federal Regulation and Chemical Innovation - ACS Publications

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